Delta, Northwest connect

Combination to form world's largest airline

United, Continental tie-up could follow soon

April 15, 2008|By Julie Johnsson, TRIBUNE REPORTER

Marking a major reordering of the U.S. airline industry, Delta Air Lines Inc. and Northwest Airlines Corp. announced Monday that they are combining operations to create the world's largest carrier, with revenue of $35 billion.

The new carrier, to be called Delta, will be headquartered in Atlanta and headed by Delta Chief Executive Richard Anderson. It will boast a global network that links Northwest's Pacific routes with Delta's trans-Atlantic offerings, as well as a stash of more than $7 billion in cash, protection against the industry downturn that has forced smaller carriers like Frontier Airlines into bankruptcy.

Northwest shareholders will receive a 16.8 percent premium in the deal, an all-stock transaction, based on Monday's share prices that value Northwest at about $3 billion.

The merger, struck after months of intense talks involving the carriers' management teams and their pilots unions, will pose thorny issues for transportation and antitrust regulators, analysts said.

That's because it is expected to trigger an even larger deal involving Chicago-based United Airlines and Texas-based Continental Airlines, say people close to the carriers. With Monday's announcement, Northwest loses the right to effectively veto a Continental merger, gained from an earlier stock deal.

"It's certainly going to put some pressure on United, which has claimed all along it wants to be the world's premier airline," said Roger King, airline analyst with CreditSights Inc. "There's only one way for [United CEO Glenn] Tilton to do it: call Houston, Texas."

Sources say that United and Continental have held detailed merger discussions, as have their pilot groups, that have left the nation's second- and fourth-largest carriers, respectively, poised to respond quickly to a Delta-Northwest tie-up.

Simultaneous reviews

A United-Continental deal could follow within weeks, analyst Kevin Crissey of investment bank UBS wrote last week, in order to be reviewed simultaneously with the Delta-Northwest deal by the Department of Justice. Airline managers have scrambled to complete the megamergers this spring in the belief the large transactions will be viewed favorably by the Bush administration. The November presidential election could lead to significant changes in the regulatory environment.

"We believe Continental management [is] not eager to deal with the hassles presented by a merger but view the long-term upside as too great and would proceed if the price is right," Crissey said.

Mergers could help the airlines gain competitive advantages by cutting costs, reducing capacity and, therefore, giving the surviving carriers a chance to charge higher fares. But in the near term, both deals likely would be fraught with labor and operational issues, as the new management teams struggle to combine disparate worker groups and aircraft fleets.

A United-Continental tie-up would eclipse the new Delta, which combines the nation's No. 3 and No. 5 carriers. The combined United network "once optimized, would be industry best," Crissey wrote.

United pilots are closely watching the compensation and work rules granted to Delta's pilots, seeing that as a potential template for concessions that they might gain for supporting a Continental deal, sources said.

Disputes to arbitration

Delta officials provided little detail of the terms of the new contractual arrangement they struck with their pilots union last week, other than to say they had extended a collective bargaining agreement with pilots through 2012, and that pilots would receive a 3.5 percent equity stake in the new company and "other enhancements."

Other U.S.-based employees of the company also will receive a 4 percent equity stake in the new Delta.

Still to be determined is the gain to be seen by the pilots of Northwest, who haven't struck new contractual terms with management, and who couldn't reach an agreement with Delta pilots over how to merge the two work groups.

Points of contention included who would fly the largest planes in the combined carrier's fleet, the Boeing 747 jumbo jets operated by Northwest, and how to integrate the two pilot unions in a manner that wouldn't leave a large number of Delta pilots at the bottom of the totem pole.

A new federal law, designed to protect airline workers in the event of a merger, likely would mean that this dispute over seniority is resolved by arbitration, experts said.

Also uncertain is how the merging airlines would balance worker expectations of large salary concessions against the brutal economics that have spurred another wave of airline bankruptcies in recent weeks.

Labor spending as a percentage of revenue at Delta, Northwest, Continental and United greatly trails that of industry leaders Southwest Airlines and American Airlines, according to an analysis by AirlineForecasts Inc., and gaining parity would require billions of dollars in additional spending that could wipe out merger savings.